Tax Notes

SC rules list of direct costs for PEZA-registered entities is not exclusive

Over the years, the determination of expenses to be allowed as deduction to gross income has been a lingering issue with enterprises registered with the Philippine Economic Zone Authority (PEZA). The controversy stems from the conflicting interpretations of the courts and the Bureau of Internal Revenue (BIR) on the provisions of Revenue Regulation (RR) 11-2005 as to whether the list of allowable deductions is exclusive or not.

The BIR originally issued RR 2-2002 wherein it highlighted that the cost of sales or direct costs shall consist only of the enumerated costs or expense items, all computed in accordance with generally accepted accounting principles. Subsequently, RR 11-2005 revoked Section 7 of RR 2-2002 and removed the exclusive nature of the costs or expenses allowed as deductions from gross income. The courts then interpreted the word “include” in RR 11-2005 to mean “to take in or comprise as part of a whole.” This definition was taken to mean a partial list, therefore giving rise to the presumption of the list’s non-exclusivity.

On March 2, 2021, the Supreme Court finally laid to rest the controversy through its decision on Commissioner of Internal Revenue vs. East Asia Utilities Corp. (G.R. 225266, Nov. 16, 2020). The Court ruled that the enumeration of direct costs that are deductible from the gross income of a PEZA-registered enterprise is not an exhaustive list and therefore, is not exclusive.

The decision is consistent with Section 24 of the PEZA Law (Republic Act [RA] 7916, as amended by RA 8748) that costs and expenses directly related to the enterprise’s PEZA-registered activity, which are not administrative, marketing, selling and/or operating expenses or incidental losses, shall be allowed as deduction from gross income.

The burden to prove that the costs and expenses are directly related rests primarily on the PEZA enterprise claiming such deductible expenses for income tax purposes.

 

Source:

P&A Grant Thornton

Certified Public Accountants

 

As published in SunStar Cebu, dated 31 March 2021